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Watchlist #7- Parag Milk Foods

  • 3 days ago
  • 3 min read
With Watchlist we pen down our broader thoughts on an idea that looks interesting and is worth keeping in one’s watchlist. This week’s idea is Parag Milk Foods.

Parag is a dairy company with focus on value added products. It is one of the leading players in organized ghee and cheese segments with its brands of Gowardhan Ghee and Go Cheese.


The reason why Parag looks interesting is because of three reasons; all of which build onto another-

  • Improving growth rates due to clear push & focus towards value added & high growth categories


  • Improving operating margins with higher mix of value-added products and operating leverage


  • Large financial leverage


Parag always has had a larger mix of value-added products like cheese, ghee etc in its revenue mix vs other dairy companies which have higher salience of liquid milk. And in last few years, the company has doubled down on the value-added segment with new business lines of Whey Protein under its Avvatar brand and premium milk brand of Pride of Cows.


As a result, its share of value-added products in overall revenue mix have started increasing and that is also resulting in improved overall growth rate for the company as these value-added product categories have higher growth vs liquid milk as a category.



Revenue growth rate has seen clear improvement to mid-teens over last few quarters;


This increased share of value-added products and improved headline growth is driving higher margins at both gross and EBITDA levels. Management here is guiding for double digit EBIDTA margins in coming years from current high single digits.


Along with operating leverage, the company also has strong financial leverage potential. Currently the company is relatively leveraged with debt of ~Rs400 crores and has interest cost outgoing of ~40-50% of quarterly PBT.


But if the company is able to continue to deliver improved headline growth rates and its operating profitability improves, the leverage can reduce meaningfully in the coming years and reduce the interest burden.


Overall, all the three factors of improved headline growth, improving operating margins and reduced finance costs will build onto each other and can result in non-linear growth in company’s profits.


And such a setup is available at TTM valuation multiple of ~23x, which is quite cheap considering the prospectus of non-linear growth in net profits.


But there are certain risks here which sort of explains why the company trades at such valuations;


1. Few Things Do Not Add Up

Back in in 2022, Parag took a big inventory write-off of ~Rs500 crores. Management rational for the same was that it had to write off certain value-added products inventory due to Covid wherein the products could not be sold. This was in stark contrast to other dairy companies none of which has seen such an impact.


Management’s indications here over the years have been that since they are more on the value-added products side, their business have different dynamics in terms of inventory and product shelf lives vs other dairy companies.


Though this makes sense, but what has been puzzling is that this whole narrative on being value added player happens only on the negative aspects of value-added products like higher working capital etc while the positives like having higher gross margins is missing.


And management has never been able to fully clarify or explain this aspect-



2. Management Conflict

Parag seems like another VIP Industries type case wherein even though you have a strong professional management team, the same gets sidelined by 2nd generation of promoter.


Parag hired Mr. Rahul Kumar in Oct’23. Mr. Kumar has strong pedigree in the dairy sector; he was earlier MD of Amul till 2011 and was then leading Lactalis (major diary MNC) for 10 years.


But if one listens to company’s concalls, it sort of gives a sense that he is getting overshadowed by the 2nd generation of the promoter. And we have seen with VIP what happens in such cases.

In summary, Parag as a stock has potential to deliver outsized returns if it is able to deliver on headline growth which will impact profits in a non-linear fashion. But it comes with certain risks and that is what needs to be tracked here.


That’s all for this one; we’ll be back with a new idea next week. Meanwhile readers can access some of our more detailed research and resources here;



Disclosures:
Surge Capital is a trade/brand name used by Ankush Agrawal (Individual SEBI Registered Research Analyst INH000008941) to provide equity research services in the Indian Equity Markets.

“Registration granted by SEBI, Enlistment with RAASB and certification from NISM in no way guarantee performance of the Research Analyst or provide any assurance of returns to investors”

“Investments in securities market are subject to market risks. Read all the related documents carefully before investing.”

“The securities quoted are for illustration only and are not recommendatory”

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